Wall Street After Fabulous Fab: Business As Usual

For anybody interested in the great financial crisis and its aftermath, there were three bits of news worthy of inspection last week. Taken together, the message they sent was depressing and somewhat alarming. Five years after the collapse of Bear Stearns and Lehman Brothers, it’s back to business as usual on Wall Street—or, at least, parts of it.

First a quick word about Fabrice (Fabulous Fab) Tourre, the former Goldman Sachs trader, who was found liable of helping his former bosses at Goldman put together a rigged mortgage deal. Juries composed of ordinary people who don’t have any financial training aren’t necessarily the best judges of complicated shenanigans carried out on Wall Street. Often, though, they get things right, and that’s what happened here. Brushing aside Tourre’s defense that he did nothing wrong, the jury found him liable on six of seven counts of securities fraud, and they also made clear that the bigger culprit was Goldman.

“I could characterize him”—Tourre—“as somewhat of a scapegoat,” one of the jurors told the Times after the verdict was issued. “It is a shame that lower-level employees get pulled in. There’s a part of me that felt it was very unfair.” Another juror said, “We were asked to look at his actions. They portrayed him as a cog, but in the end the machine is made up of cogs, and he was a willing part of that.”

Goldman wasn’t actually in the dock, of course. In a now notorious 2010 settlement with the Securities and Exchange Commission, the big bank was allowed to settle the case without admitting any guilt for five hundred and fifty million dollars—a slight sum to a firm that made almost two billion dollars in the second quarter of this year alone. But make no mistake, the jury thought that Goldman, and, indeed, the rest of Wall Street, was culpable for Tourre’s actions. In the case at hand, he had helped Goldman sell some mortgage-related securities partly selected by one of the bank’s biggest clients, the hedge-fund manager John Paulson, who was shorting them, while failing to inform the investors who bought the securities of Paulson’s involvement. The prosecutor “told us at the beginning that we would see this was all about Wall Street greed, and we did get to see that,” a third juror told the Times.

In a post on our site, Michael Santoro, a professor of business ethics at Rutgers, pointed out that the 2007 deal at the center of the case, which was called Abacus, and which Tourre, in an e-mail to his girlfriend, described as a “monstrosity,” wasn’t particularly unusual. Also in 2007, Goldman put together at least three similar deals—they were called Anderson, Hudson, and Timberwolf—without telling investors that the bank itself, having divined that the mortgage market was imploding, had bet against similar securities. Elsewhere on the Street, other banks and hedge funds, such as JP Morgan and Magnetar, were putting together similarly self-serving deals, many of which haven’t ended up in court.

That brings me to the second bit of news, which was actually more of a reminder, courtesy of an article at Marketplace. With the fifth anniversary of Lehman’s bankruptcy coming up, on September 14th, the statute of limitations in cases involving alleged violations of the securities laws is also coming up. Indeed, since much of the dubious activity involving mortgage bonds took place between 2005 and 2007, the cutoff date for pressing charges has, in many cases, already come and gone.

It has been widely noted that Tourre is the first and only Wall Street banker to be found guilty of any charges having to do with the financial crisis. Like Goldman, some other firms, including Citigroup, have settled cases brought by the S.E.C., paying fines without admitting any wrongdoing. Yet other banks, including UBS and Bank of America, are reportedly still in negotiations with the SEC, or likely to face charges, but it seems unlikely that they will concede any wrongdoing (although Mary Jo White, the new head of the S.E.C., is said to be reluctant to agree to any more such deals) or face any lasting damage to their businesses.

Then there are the individual cases. Perhaps the most controversial involved Angelo Mozilo, the former C.E.O. of Countrywide Financial, who agreed to pay a $22.5 million fine and disgorge $45 million in ill-gotten gains to settle charges of insider trading and misleading investors. A number of other cases are still outstanding, but none of them involve the big Wall Street firms who were at the heart of the subprime securitization industry. The most prominent targets are Daniel Mudd, the former chief executive of Fannie Mae, and Richard Syron, the former head of Freddie Mac.

It is well to remember that these are all civil cases brought by the S.E.C. As for the Justice Department, since losing a 2009 case involving two former hedge-fund managers at Bear Stearns, the agency hasn’t brought criminal charges against anybody on Wall Street for actions related to the financial crisis.* For years, an F.B.I. task force concentrated on nailing lowly mortgage brokers who issued fraudulent individual loans. More recently, a Justice Department task force devoted to financial frauds has been setting its sights higher, but these investigations have yet to yield any indictments, and, with the statute of limitations approaching in a number of the cases, many observers suspect that they never will.

Is that such a terrible thing? In my book on economics and the financial crisis, which was published in 2010, I angered some people by suggesting that Chuck Prince, Stan O’Neal, John Thain, and the other Wall Street C.E.O.s involved in the run-up to the financial crisis were “neither sociopaths nor idiots nor felons. For the most part, they are bright, industrious, not particularly imaginative Americans who worked their way up, cultivated the right people, performed a bit better than their colleagues, and found themselves occupying a corner office during one of the great credit booms of all time.”

Even today, I stand by the judgment that the major cause of the financial crisis, rather than outright criminality, was an incentive structure that encouraged risky behavior all along the mortgage chain. But, with the benefit of hindsight, it’s also clear that there was also quite a bit of action that crossed over into misleading and defrauding investors: to borrow a phrase from John Kenneth Galbraith, “the bezzle” was on. Many of these acts, which took place with the encouragement, if not the active involvement, of people at the very top of the Wall Street hierarchy, have largely gone unpunished.

If there’s one thing we know about dubious behavior, it’s that failure to stamp it out encourages more of it. Which brings me to the third bit of news from last week, which came courtesy of a survey carried out for the Times by a research firm called Commercial Mortgage Alert: Standard & Poors, one of the world’s biggest credit-ratings agencies, is “winning business again by offering more favorable ratings.” With the recent revival of the real-estate market, commercial-mortgage securitizations are reviving, and so is the demand for ratings from credit-ratings agencies. According to the Times report, in the first half of 2013 Standard & Poors gave higher ratings to a number of securitizations than its rivals Moodys and Fitch did, and, consequently, its market share tripled.

In the aftermath of the financial crisis, there was much talk of changing the way mortgage bonds are rated. In particular, there were calls to replace the “issuer pays” practice, in which the financial institution that is issuing the bonds shops around the credit agencies for a favorable rating and then pays the agency for its opinion. But in this area, as in others, nothing really changed, and the incentives for bad behavior remained in place.

S. & P., which is still facing an S.E.C. lawsuit that accuses it of inflating its ratings during the pre-crisis housing boom, said the methodology used in the Times survey was flawed. But other experts quoted in the piece saw signs of old ways returning. One of them, Edward Shugrue, the chief executive of Talmage, a New York firm that invests in commercial mortgage bonds, said, “You can see that we are slipping our way back to 2007.”

Yes, it’s only one part of the mortgage market—and not the one that caused all the trouble last time around. So far, the market for issues of subprime mortgage bonds remains closed. Nonetheless, it’s a warning sign worth noting.

*Note: I’ve corrected this post to reflect the fact that, in 2009, the Department of Justice brought criminal charges against two former Bear Stearns employees. The original post said that it hadn’t brought criminal charges in any case related to the financial crisis. Sorry for the error.